Choose wisely between dividend and growth option

Many mutual fund investors face a common dilemma. Should you choose growth, dividend payout or dividend reinvestment option? While each option is distinctly different, earning potential vests in all three.

Many mutual fund investors face a common dilemma. Should you choose growth, dividend payout or dividend reinvestment option? While each option is distinctly different, earning potential vests in all three.

Many mutual fund investors face a common dilemma. Should you choose growth, dividend payout or dividend reinvestment option? While each option is distinctly different, earning potential vests in all three. One needs to understand one’s financial needs to choose the right option, advises Hemant Rustagi of Wiseinvest Advisors.

The growth option, as the name suggests, allows investors to make their money grow over a period of time. So, anyone who is looking to build his corpus over a period of time should look at growth option.

As far as dividend payout option is concerned, those investors who would like to receive dividend on a regular basis, can opt for it. The major advantage here is that the dividend that comes in the hands of investor is tax free.

Dividend re-investment is not advisable for investors especially who invest for the long term. It’s ideally suitable for investors who want to park their money for couple of months in funds like liquid fund or ultra short term fund.

Below is the edited transcript of Rustagi's interview with CNBC-TV18.

Q: While investing in mutual funds, how should an investor decide between which option to pick - dividend pay out, dividend reinvestment or growth. Also, should one keep interchanging between these options depending on the market conditions? How would it imply for an equity mutual fund and a debt mutual fund?

A: As far as selecting an appropriate option is concerned, I think it’s a very important aspect of mutual fund investing. In fact, I would say it’s as important as selecting the right scheme. But this is unfortunately one aspect which is generally ignored by the investor.

Let’s begin with growth option. As the name suggests, it allows investors to make their money grow over a period of time. So, anyone who is looking to build his corpus over a period of time should be looking at growth option.

The reason for that is, in the growth option, whatever gains are made on an investment remain invested in the fund itself. This means that one gets the advantage of the power of compounding over a period of time. This is very important especially for someone who wants to build his corpus over a period of time.

The second aspect is that the growth option ensures that the returns that an investor gets become more tax efficient, and that depends on the kind of scheme that money is invested in. For example, if the money is invested in equity funds, capital gains, on an investment which is redeemed after a period of 12 months, are tax free. In case of debt fund, it is tax at a concession rate of 10%.

In fact, there is another option for an investor, that is to claim indexation benefit. In a country like ours, where generally inflation is quite high, it makes sense to claim indexation. For example, if the return from a debt fund is 10% and the inflation is at 8%, the tax has to be paid only on 2% which is at 20%. So, the post tax return turns out to be 9.6%.

If you were to compare it with a traditional option like fixed deposit (FD), although you get the same return, if you are in the higher tax bracket, you end up paying 30% tax on that. So, as against 7% you get 9.6% so growth option is suitable for investors who wants to make their money grow.

As far as dividend payout option is concerned, those investors who would like to receive dividend on a regular basis, can opt for it. Of course, the frequency of the dividend depends on the kind of fund one is invested in. Equity funds give you dividends once in a year. But many of the debt funds have the option of either getting dividends on a daily basis or a monthly basis or a quarterly basis.

The major advantage here is that the dividend that comes in the hands of investor is tax free. But in case of debt funds, the funds have to pay dividend distribution tax, which for individuals, is 13.52%. For those investors who are on the higher tax bracket of 20% and 30%, there is a clear tax arbitrage.